4.1.8.1 How markets and prices allocate resources

Question 1

Functions of price

Answer 1

1. Rationing function
2. Signalling function
3. Incentive function
4. Allocative function

Question 2

Rationing function

Answer 2

• As prices rise - excess demand removed - only consumers with ability to pay are able to purchase the good (increasing prices rations demand to those most available to afford a good)

Question 3

Signalling function

Answer 3

• Prices provides market signals (provide important info) to market participants

Question 4

Incentive function

Answer 4

• Increased prices strengthen incentives to firms to produce more in order to make a profit

Question 5

Allocative function

Answer 5

• Acts to divert resources to where they can maximise their returns and a way from uses where they do not